So U.S. policymakers should watch out for Russian efforts to avoid sanctions through trade with China.
The Soviets had a joke about a worker at a military factory who complained that no matter how hard he tried to assemble a child’s pram, he always ended up with a Kalashnikov rifle. More recently, a vice president of Russia’s leading energy company lamented that civilian and dual-use equipment produced by the defense industry “should be normal, like abroad, and not in the form of a tank.” Little has changed, it would seem, in Moscow’s efforts to enforce cooperation between the civilian-commercial sector and the defense-military one.
The impetus this time is Vladimir Putin’s attempt to accelerate his country’s science and technology development, which he calls vital to preserving “Russian civilization.” Handicapped by international sanctions and low energy prices, the Russian government has ordered its energy sector and its defense industry (OPK, for short) to combine efforts in R&D and production. But this is currently causing more problems than solutions. It is important for Western governments to understand how and why.
Since 2014, when the West imposed sanctions to punish Russia for annexing Crimea, Moscow has prodded its companies to create homegrown alternatives to products no longer available from abroad. This has produced only mixed results, with a low share of high-tech items. So the Russian government revised its approach, aiming to foster collaboration between the energy sector, with its lavish research funding, and its tech-heavy defense sector. But the Kremlin also has reduced defense spending, gradually since 2015 and with plans for more drastic cuts through 2027.
To compensate, the government revised its approach again. Inspired by the “Chinese model”, officials are now ordering defense companies to devote an increasing share of their production capacity to civilian and dual-use products. Official goals have been set: 30 percent in 2030; up to half by 2050.
By linking the diversification of the defense sector with the import-substitution programs of the energy sector, the government aimed to kill two birds with one stone. The energy companies could advance their import-substitution targets and reduce the dependence on foreign items in such areas as equipment for the Arctic shelf, subsea and seismic exploration equipment, and navigation systems and software. And defense companies could use profits from civilian products to keep up their factories.
But it’s not yet working out that way. One problem is that there’s no easy way to get the necessary funding to reconfigure defense factories. Russian firms have relatively little access to capital in general; moreover, most defense companies cannot get bank loans—although a timid step in this direction was recently made, and the government has created various paths to funding, including low-interest loans from the Fund for Industrial Development. A second problem: OPK companies have little expertise in designing, producing, and marketing commercial products. Nothing guarantees they will fare well under market conditions.
Predictably, most of the limited attempts at diversification and inter-sectoral collaboration have been made by Russian national champions, such as Rostec, Roscosmos, and Rosseti.
VEB and Rostec, for example, launched a joint venture they call “Conversion.” UEC Perm Engines produced gas turbines for Russia’s most ambitious projects such as Power of Siberia, Yamal LNG, and Nord Stream 1. Roscosmos manufactured drilling equipment components and subsea production systems for Gazprom. Rostec signed an agreement with Slavneft-Yanos, one of Russia’s largest refineries, on the supply of anti-drone systems to avert potential attacks. But these examples of success meet just a fraction of the import-substituting needs of the energy majors.
Technical obstacles still hinder defense-energy cooperation, lack of understanding of what needs to be done on both sides, limited cooperation between engineering and service centers, absence of clear-cut production priorities from the energy companies, lack of centralized databases in the OPK for stock management, etc. The industries have different ideas about production cycles: for the military industry, for instance, deadlines and prices are of secondary importance compared to technical requirements.
Even human factors create friction. There are reports of tension between the people who lobby for the energy and defense sectors. Many in the OPK and the armed forces are reluctant, even disdaining, about collaborating with “civilians” from the energy sector. There are spats between those who favor localization with foreign participation and those preferring homegrown production for “state security” reasons.
And basic questions about the proper approach remain unresolved. While the Military-Industrial Commission has been lobbying for guaranteed quotas for purchases from Russian defense industries as part of import substitution, the Finance Ministry and the Federal Anti-Monopoly Services advocates a more “market-oriented” mechanism prohibiting the procurement of foreign production if two Russian analogues are available. Blanket quotas would help the OPK increase the scope of procurement for Russian products as well as the share of civilian participation—and therefore “shield’ uncompetitive Russian companies from foreign suppliers. A compromise was recently found when the Ministry of Industry and Trade agreed to make a list of quoted items for each project—provided they do not contradict WTO norms.
Things are only going to get more difficult. The Russian energy sector is losing its ability to subsidize other sectors of the economy, thanks in the near term to the demand slump caused by the COVID-19 pandemic, and in the long term to global efforts to reduce carbon emissions. The competition for state funds will become fiercer and the allocation of public funds more selective. The balancing of different interests will become even more problematic.
Moreover, Western policymakers have reacted to Putin’s attempts to stimulate import-substitution and civil-military cooperation by placing new limits (and removing various exemptions to existing limits) on exports to Russia.
What next? U.S. policy makers should be more vigilant of Russia’s turn to China for civilian items with dual-use applications. Keeping an active eye on Sino-Russian military-technical cooperation is now a question of national security for the United States. As Beijing is increasingly interested in acquiring controlling stakes in military industry companies of third-party countries, there is a risk of spillover at the benefit of Russia. This could become detrimental to the sanctions regime and help the Kremlin circumvent it. Another way to pressure the Russian military industry would be to increase the U.S. technological gap with Russia through targeted and specific defense procurement in modern warfare capabilities and breakthrough military technology.
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